Russian Finance Minister: We Can No Longer Afford Our Military Spending Plan

Russian President Vladimir Putin attends a welcoming ceremony as he inspects the Vice-Admiral Kulakov anti-submarine warfare ship in Novorossiysk, September 23, 2014. His visit was marked by Vice Admiral Alexander Vitko's comments on the Black Sea fleet's expansion. Mikhail Klimentyev/Reuters Russia's finance minister said on Tuesday the country could no longer afford a multi-billion-dollar revamp of the armed forces approved by President Vladimir Putin, stepping up a campaign to trim spending as sanctions over the Ukraine crisis bite.

Anton Siluanov said a new defense program should be drawn up to take into account the changed economic situation, even though the deputy prime minister in charge of the sector has been ruling out any cuts in military spending.

"A new defense program will be prepared now, and in its framework we want to reconsider the amount of resources that will be spent from the budget in order to make it more realistic," said Siluanov, appointed three years ago after his veteran predecessor, Alexei Kudrin, quit in protest over the proposed military spending.

Russia's Finance Minister Anton Siluanov attends the Reuters Russia Investment Summit in Moscow September 24, 2014. Maxim Shemetov/Reuters Siluanov's comments highlight a battle among different factions of the government over defense spending which has heated up in recent months, and which will ultimately be resolved by Putin himself.

They could indicate the president is preparing the way to postpone or trim some defense spending, foreseen at 23 trillion roubles ($576 billion) in the decade to 2020 under his original plan to upgrade 70 percent of military equipment by then.

"Since all such final decisions are made in the Kremlin, the decision about fine-tuning of the program will be made in the Kremlin and opponents of the finance ministry's proposals to adjust it will have to obey," said Ivan Konovalov, head of the Moscow-based Center for Strategic Trends Studies.

"We Can't Afford It"

When the ambitious program to revitalize the Russian army and its aging equipment was first proposed in 2011, the government expected gross domestic product growth of 6 percent throughout the decade.

But the economy may grow by 0.5 percent at best this year, and the International Monetary Fund and World Bank forecast stagnation in the next two years.

"When we were adopting the defense program, the forecasts for the economy and budget revenues were completely different. Right now, we just cannot afford it," Siluanov said.

Western sanctions against Russia over the Ukraine crisis are choking economic growth, weakening the rouble and isolating the market from foreign funding. Along with finance and oil, the arms industry is one of those targeted by the measures, which bar some top companies from seeking finance on Western capital markets and ban the sale of sensitive technology to nine Russian defense firms.

Deputy Prime Minister Dmitry Rogozin has previously said, however, that modernization of the military will continue as envisaged by Putin's decrees. "The idea is that by 2015 we should have upgraded 30 percent of military equipment, and by 2020 - 70 percent," Rogozin told the daily Kommersant in an interview.

He added that state defense orders could not be transferred "blindly" at the whim of the Finance Ministry -- at least, not without revising the presidential decree. "The program itself, the amount of funds allocated for it is not subject to revision," he said.

But Konovalov, the defense analyst, said that while some projects, such as modernizing Russia's air force, submarine forces or space technology will definitely continue at full speed, there is room to cut others.

A Russian officer takes a picture of a Tu-95 bomber, or "Bear," at a military airbase in Engels, some 900 km (559 miles) south of Moscow, August 7, 2008. Sergei Karpukhin/Reuters "Consensus will have to be found," Konovalov said. "The initial plan did not take into account the fluctuations in the financial markets."

Some of the projects were created in haste. "Some were even to a certain extent populist," he said.

The 10-year-programme was created before the 2012 presidential election that brought Putin back to the Kremlin after a four-year stint as prime minister.

Higher spending, lower oil

While data from the Stockholm International Peace Research Institute show that U.S. military spending fell last year, Russia's increased in real terms, exceeding that of the United States for the first time since 2003 and reaching 4.1 percent of GDP.

Between 2004 and 2014, Russia doubled its military spending and according to the newly adopted budget, it will further increase it from 17.6 percent of all budget spending this year to 20.8 percent, or 3.36 trillion roubles ($84.19 billion), in 2017.

But the new budget, which envisages a deficit of no more than 0.6 percent of GDP over the next three years, is based on oil prices of $100 per barrel. On Tuesday, Urals, Russia's main blend, was at around $90 per barrel.

Siluanov admitted that the oil price penciled in the budget "already today seems high." Receipts from oil and gas make up nearly half of government revenues.

"We should have planned the budget more tightly, with a surplus," Siluanov said.

The decline in oil prices has been one of the chief factors that have pushed the rouble to all-time lows of 40 to the dollar..

Sanctions on Moscow for its involvement in Ukraine have cut growth by an estimated 1 percentage point this year, according to former finance minister Kudrin, and economists expect that the acceleration in capital outflows and the decrease in investment activity will hinder growth in coming years too.

The central bank and the finance ministry have begun work on a worst-case scenario that would provide for monetary and fiscal mechanisms to support the economy and the currency if oil prices were to drop to $60 per barrel.

On Monday, Putin signed a law that would allow the government to tap one of the country's oil windfall revenue funds, the Reserve Fund, next year, for the first time since the aftermath of the 2007-8 global financial crisis. The Fund has some $90 billion in it.

"Russia should refocus on domestic economic policy and avoid further distancing itself from its global economic partners," analysts at Uralsib in Moscow wrote in a note.

"Given the negative impact of recent geopolitical events and the government's tightening of economic policy, we believe that Russia may not be able to achieve its long-term economic growth potential until 2017."